Navigating the Economic Landscape

Orin Kramer Provides More ‘Sense on Cents’

Posted by Larry Doyle on February 22, 2010 10:10 AM |

I first introduced Orin Kramer, chairman of the council overseeing the New Jersey State Pension, to readers of Sense on Cents on January 5th. On that date I wrote “Public Pension ‘Smoothies’ Will Cost $2 Trillion”, highlighting the massive gap in the funding of our public pension system.

Last evening on my radio show, my guest Ronald Holland addressed how we should ultimately expect our retirement funds to be taken over by the government partially for the purpose of funding these pensions. You can listen to the entire interview with Mr. Holland here.

We wake up this morning and are revisited by none other than Orin Kramer, who provides a succinct but enlightening View From the Top interview to the Financial Times:

For more than a decade, Orin Kramer has sounded warnings about the mounting funding crisis facing nearly every US state’s pension fund. Mr Kramer is chairman of the council that oversees New Jersey’s state pension fund, one of the largest in the US, and also a highly influential behind-the-scenes figure in the Democratic party. He is deeply worried that the growth of obligations to teachers and other workers in many states has outstripped their investment returns.

FT: In a recent report, it was estimated that the funding gap in state pensions and other obligations is $1,000bn. Your estimate is even higher than that. What is your estimate and why is it higher?

OK: In simple terms, if you use the accounting standards that are applied to corporations, the shortfall for the states, what they ought to have today and don’t have, is $2,000bn-plus for the public pension funds and probably another $1,000bn-plus for the health [obligations] side.

FT: So $3,000bn in total?

OK: If you use government accounting constructs, pension funds are probably about 88 per cent funded. If you just tweaked one variable and said, you know what, instead of using the average assets for the last five years, and assuming that’s what we have, let’s actually take market values year-end 2009. That brings you down from 88 to 75 per cent funding. And then if you say, let’s use corporate accounting that doesn’t allow you to assume double-digit returns from equities and so forth, that would make those funds 60 per cent funded, which translates into a $2,000bn-plus shortfall on the public fund side, before you get to the health piece.

I hope people can appreciate the integrity and the gravity of the points highlighted here by Kramer. Pension funds are typically far too aggressive in terms of assumptions of investment returns.

FT: What kind of solutions would work?

OK: If you assume 8 per cent annualised returns, which is what they assume, which is more aggressive than I’d want to be, but if you assume 8 per cent returns, and you assume . . . the levels of contributions you’ve had in recent years, the average state fund actually runs out of cash in 2025, so my guess is before 2025 you sit people down in a room, like they did in New York City in the late 1970s.

FT: For people managing public pots of money, is it going to be more difficult to invest in alternative assets in the wake of the crisis?

OK: I have seen one thing that’s been coming up more among public funds, which is wanting to lever Treasuries and lever Tips [Treasury inflation- protected securities] in order to generate higher yields. And that to me is reminiscent of when pension funds went out and began leveraging themselves and borrowing against themselves. The trade is working but, to me, “carry trade” and “pension fund” shouldn’t be in the same sentence.

FT: What is your economic outlook?

OK: I want to bring household debt [relative to people’s disposable incomes] levels back to the ratio not of 1982 but what we had in 2000 relative to gross domestic product. That is a 25 per cent reduction [in the US], one-third off in the UK and about a 50 per cent reduction in Spain. So those kinds of long-term challenges, exiting this extraordinary fiscal and monetary stimulus, these are going to be difficult processes to negotiate. I think we haven’t had any deleveraging yet. We’ve just substituted government borrowing for less activity in the private sector. That’s not a sustainable model.

If Mr. Kramer’s analysis causes you concerns and you are wondering what the states and municipalities might do to address their massive pension shortfalls, I recommend you go back and listen to my interview with Ronald Holland. Ron cogently lays out how the government will write more IOUs while taking in the retirement holdings of many American citizens, which will in turn be used to fund these pensions. This approach would merely be another massive Ponzi-scheme to redistribute wealth in the name of good public policy.

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